Summary

The Express segment has improved dramatically while Ground margins have started to erode a little.

Free-cash-flow has been razor thin the last few years, would like to see FedEx get to 5% FCF yield.

Longer-term I still worry about Amazon's trucks in high-density urban areas, although FedEx management says such concerns are "fantastical".

Federal Express (NYSE:FDX) reports after the closing bell on Tuesday, March 21, 2017, with analyst consensus expecting $2.62 in earnings per share on $15 billion in revenue, for expected year-over-year growth of 4% in EPS on 19% in revenue.

The real story of the last few years for FedEx has been the turnaround in Express, which has fallen to half of FDX's revenue, down from 60% - 6% in 2012 - 2013, but the drastic improvement in Express's operating income and margin, which is now up to half of FDX's total operating income and the Express operating margin which has improved from 2% as of Feb '14, to 7.5% as of last quarter.

Express for years was a story of shrinking or gradually falling volumes, while the Ground division was shooting the lights out but today, the roles have somewhat reversed as the Express division has become much better operationally, while Ground volumes have started to flag just a bit.

Here is a quick breakdown of FDX's segments by revenue:

11/16

8/16

5/16

2/16

Express

45%

46%

52%

52%

TNT

13%

12%

Freight

11%

11%

12%

11%

Ground

30%

29%

33%

35%

(not included is "other" which is roughly 2% - 3% of total FDX rev)

Source: FDX Stat book, earnings releases, 10-Q's

FDX's segment breakdown by operating margin:

11/16

8/16

5/16

2/16

Express

9.43%

9.38%

11.27%

9.07%

TNT

3.7%

-0.08%

Freight

5.5%

8.1%

8.5%

3.9%

Ground

10.5%

14.2%

15.3%

12.6%

Source: Stat book, earnings releases, etc.

Here are FDX's consensus EPS and revenue estimates for '17 - '19:

2/17 est

11/16 q2

8/16 q1

5/16 q4

2019 EPS est

$15.45

$15.47

$15.09

$15.13

2018 EPS est

$13.52

$13.50

$13.61

$13.47

2017 EPS est

$12.00

$12.00

$12.15

$11.92

2019 est EPS gro rt

14%

13%

11%

12%

2018 est EPS gro rt

13%

13%

12%

13%

2017 est EPS gro rt

11%

11%

13%

11%

2019 P.E

13(x)

12(x)

11(x)

10(x)

2018 P.E

14(x)

14(x)

12(x)

12(x)

2017 P.E

16(x)

16(x)

13(x)

13(x)

2019 est revenue

$66.0

$65.7

$65.2

$65.5

2018 est revenue

$62.9

$62.9

$62.7

$62.9

2017 est revenue

$60.1

$60.0

$60.0

$60.0

'19 est rev gro rt

5%

4%

4%

4%

'18 est rev gro rt

5%

5%

5%

5%

'17 est rev gro rt

20%

20%

20%

20%

Source: Thomson Reuters I/B/E/S est's as of 3/20/17

"est" - consensus estimate for coming quarter

One thing that should jump out at readers is that FDX is currently attractive on a P.E to growth or PEG basis with mid-teens growth expected next 3 years, and the stock trading at mid-teens multiple to those earnings.

Here is what worries me about FedEx: using the 2016 annual report, here is the last 3 years of cash-flow from operations, capex and free-cash-flow:

fy 2016

fy 2015

fy 2014

Cash-from-ops

$5,708

$5,336

$4,264

capex - regular

($4.818)

($4,347)

($3,533)

Acquisitions

($4,618)

Free-cash-flow

($3,720)

$989 ml

$731 ml

$'s in millions

Source: FDX 2016 annual report

Using my own valuation spreadsheet, here is what FedEx's cash-flow statement looks like the last 16 quarters:

Cash-from-ops (TTM)

capex

FCF

FCF Yld

11/16

$5.9 bl

$4.9 bl

$1.0

2%

8/16

$5.4

$4.8

$0.6

1%

5/16

$5.7

$4.8

$0.9

1%

2/16

$5.7

$5.0

$0.7

1%

11/15

$5.7

$5.5

$0.2

0%

8/15

$5.6

$5.5

$0.10

0%

5/15

$5.4

$5.8

($0.4)

0%

2/15

$5.2

$5.3

($0.1)

0%

11/14

$4.8

$4.7

$0.1

0%

8/14

$4.3

$4.4

($0.1)

0%

5/14

$4.3

$3.5

$0.8

2%

2/14

$4.3

$3.2

$1.1

2%

11/13

$4.6

$3.2

$1.4

3%

8/13

$4.7

$2.9

$1.8

4%

5/13

$4.7

$3.4

$1.3

3%

2/13

$4.8

$3.8 bl

$1.0

2%

$'s in billions

All dollars trailing twelve months

Capex includes acquisitions, expect TNT

Technical analysis:

FDX has been consolidating after last quarter's weaker earnings report.

$150 would be strong support on this chart or the 200-week moving average.

Analysis/conclusion:

Last quarter the stock was weak after Ground operating margin fell and FedEx management guided to a flat Express quarter for this fiscal Q3 '17 which gets reported Tuesday night, however FedEx is known for conservative guidance or under-promising and over-delivering.

Valuation is not a timing tool, and while the stock looks cheap on a PEG basis and revenue is expected to grow sharply the bump in revenue growth is likely TNT driven off last year's non-TNT year, and at $195 per share I can't really get excited about putting fresh money into FDX here.

A lot of the tailwinds the stock has seen the last few years including lower fuel costs which have declined from 10% to 5% of revenue the last three years, the improvement in Express margins and the big share buyback have gone away or at least not been increased, thus the case can be made for more downside than upside.

However as European developed markets recover and FedEx fattens TNT's margins, there are some potential positives to the story.

Finally, living just north of downtown Chicago, I see a lot of Amazon (NASDAQ:AMZN) trucks out and about regularly, and while I chat up FedEx drivers and they tell me the lost business is still minimal, I wonder how long FedEx can go until Amazon starts to make just marginal inroads into Ground.

FedEx and Fed Smith noted 2 -3 quarters ago on a conference call that worries about Amazon's inroads into FedEx's Ground business were "fantastical" so we'll see.

For clients accounts, I just want to own the stock much lower.

Don't assume that with this write-up FDX can't be up $5 after Tuesday night's results, but for me to commit a decent percentage to client accounts here, I would need to see FDX much lower.

Disclosure:I am/we are long FDX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Invest alongside Brian Gilmartin, CFA

www.trinityasset.com

Our favorite strategy at Trinity Asset Management, Inc., is to pick a few favorite stocks within the sectors we like longer-term, then use ETFs to add style components to the portfolio and some sector rotation.